Many people, including attorneys who do not practice intensively in the estate planning arena, assume that if a trust is irrevocable its terms are immutable. But that is not the case because like many other states, Rhode Island has a decanting statute which was enacted in 2012 and amended in 2013. The context we are considering in this article is either a revocable trust that has become irrevocable by definition because the grantor is mentally incapacitated or has deceased, or a trust that is irrevocable by its terms.[1] This includes trusts wherein the grantor does not explicitly reserve the power to revoke the trust which the Rhode Island Supreme Court has relegated to irrevocable status[2]
There are many reasons why a trustee or beneficiaries would want the terms of a trust to be altered. The law may have changed since the drafting of the trust, a likely concern in the wake of the recent Tax Cut and Job Act. Changes in family circumstances may give rise to a predilection to change the terms of the trust. For example, possibly a beneficiary has become a special needs person or has developed creditor problems and the trust does not contain provisions to insulate the beneficiary’s allotment from dissipation. Perhaps a drafting error needs to be corrected. It may be beneficial to enhance the trustee’s powers to invest in a certain way. There are many reasons to change the terms of a trust which is irrevocable and there is statutory prerogative for doing so but, as we shall see, there is not carte blanche in effectuating such a change through decanting.
Decanting was recognized at common law in certain jurisdictions in cases in which the trust under consideration authorized the trustee to invade principal on behalf of the beneficiaries.[3] A seminal case on this issue is Phipps v. Palm Beach Trust Company, 196 So. 299 (Fla, 1940) wherein the trust contained such a provision. The individual trustee instructed the corporate trustee to transfer the trust property to a new trust which vested one of the beneficiaries with a testamentary power to appoint income to the beneficiary’s spouse, for which de facto decanting the corporate trustee sought court approval. In deciding that such a transfer to a different trust to effectuate the change was permissible, the Florida Supreme Court cited the general rule “that the power vested in a trustee to create an estate in fee includes the power to create an estate in less than a fee unless the grantor clearly indicates a contrary intent.”
Common law principles dictate that a trustee must not violate his or her fiduciary duties in taking any actions, which certainly would include decanting. This essentially means that the trustee may not act arbitrarily. The best interests of the beneficiaries must be served in a fair and impartial manner. The trustee must act prudently in protecting trust property and must keep beneficiaries reasonably apprised of trust administration. Failure to inform beneficiaries of the divestment of the original trust and transfer of its assets to a newly formed trust with different terms would certainly constitute a breach of fiduciary responsibility on the part of a trustee.
Rhode Island’s decanting statute is found at RIGL §18-4-31. It is entitled “Power to Invade Principal in Trust.” This article will examine the statute from three perspectives: (1) conditions that must be in the original Trust as a pre-requisite to decanting (2) methodology of decanting and (3) limitations on the power to decant.
Pre-Requisites to Decanting
Decanting is not a resource if the original trust is a Supplemental Needs Trust or a Special Needs Trust created in accordance with 42 USC §1396(d)(4)(A). This makes sense since the beneficiary of such a trust is disabled and presumably would not be in a position to object to, or successfully challenge decanting. The verbiage in the statute is somewhat confusing, however, because many elder law attorneys distinguish between Special Needs Trusts also referred to as “d4A Trusts” which are First Party Trusts subject to limitations set forth in the federal statute and Supplemental Needs Trusts which are third party trusts commonly created by a parent or grandparent for their disabled child(ren) or grandchild(ren). The former category of trusts must contain a pay-back provision directing the balance of trust funds remaining in the trust after the death of the disabled beneficiary to be paid over to the state to the extent it has subsidized the disabled person’s healthcare costs, whereas the latter type of trust need not contain such a provision. Inasmuch as the Rhode Island statute specifically references the federal statute, arguably only “d4a” trusts are excluded from the power to decant.
The terms of the original trust must empower the trustee to invade principal for the benefit of one or more beneficiaries. The statute states:
A trustee who has authority under the terms of a trust to invade principal of the trust, referred to in this section as the “first trust” to make distributions to or for the benefit of one or more persons, may instead exercise such authority by appointing all or part of the principal of the trust subject to the power in favor of a trustee of another trust, referred to in this section as the “second trust,” for the current benefit of one or more of such persons under the same trust instrument or under a trust instrument…”
The original trust must not contain a prohibition against invasion of principal by the trustee as part of a provision prohibiting amendment or revocation of the trust itself.
Methodology of Decanting
The exercise of a power to invade principal and to decant shall be by an instrument in writing, signed and acknowledged by the trustee, and filed with the records of the original trust.
The exercise of the power to invade principal and to decant shall be considered the exercise of a power of appointment, other than a power to appoint to the trustee, the trustee’s creditors, the trustee’s estate or the creditors of the trustee’s estate. In other words, it is to be considered a limited power of appointment.
A trustee who intends to exercise its power to decant must notify all beneficiaries defined in the statute as Qualified Beneficiaries of the original trust. A Qualified Beneficiary is defined in the statute as a living beneficiary, who on the date the beneficiary’s qualifications are determined (a) is a distributee or permissible distributee of trust income or principal (b) would be a distributee or permissible distributee of trust income or principal if the interests of the distributees referenced above terminated on that date without causing the trust to terminate, or (c) would be a distributee or permissible distributee of trust income or principal if the trust terminated in accordance with its terms on that date.
The notices must inform all Qualified Beneficiaries in writing, at least 60 days prior to exercising the decanting power, of the manner in which the trustee intends to exercise the power to invade principal. A copy of the proposed instrument exercising the power satisfies the notice requirement. If all Qualified Beneficiaries waive the notice requirements by written instrument delivered to the trustee, the trustee’s power to invade principal may be exercised immediately.
The notice requirement does not strip a Qualified Beneficiary of the power to object to the exercise of the trustee’s power to invade principal. The statute is silent on what recourse, beyond objection, such beneficiary may access judicially.
The power to invade principal and decant to another trust as codified in the statute does not create a duty on the part of the trustee to do so. This presumably insulates a trustee who chooses not to exercise the power to invade principal from absolute liability for not doing so. On the other hand, arguably the common law principles that apply to trustees including prudence, responsibility to preserve principal, etc. may provide a basis for establishing culpability in such a case.
Limitations on Exercising Decanting Power
In exercising decanting power, the trustee must be cognizant of the requirement that “(t)he beneficiaries of the second trust may include only beneficiaries of the first trust.”
The second trust may not reduce any fixed income, annuity or unitust interest in the assets of the first trust, and
If any contribution to the first trust qualified for a marital or charitable deduction for federal income, gift or estate tax purposes under IRC 26 U.S.C. §1 et seq., the second trust shall not contain any provisions which would have prevented the first trust from qualifying for such a deduction or would have reduced the amount of such deduction.
[1] Trusts which are designed to protect trust assets from the grantor’s creditors including long term care costs are examples of trusts that are intentionally irrevocable.
[2] Garneau v. Garneau 63 RI 416, 9 A2d 15 (1939)
[3] Restatement 2nd of Property, Donative Transfers, §§11.1-12.3; Restatement 3rd of Property, Wills and Other Donative Transfers §17.23